Category Archives: Economics

Dealing with Price Volatility in the Turbulent Global Marketplace

In the Hackett Group’s recent insight on “Taming the Inflation Dragon”, we find out that the average company is facing a 9% drop in corporate profits this year due to rising prices and other inflationary pressures and that this translates into a 150 Million hit to the bottom line for a typical Global 1000 company with 27.8 Billion in revenue. Ouch!

Obviously, the company is counting on the supply management organization to control costs despite the rampant price increases in a market where commodity inflation has not only increased by 30% overall but where price volatility has increased nearly 60% since before the recession. Not an easy challenge, especially since speculation in commodity markets is having a major impact on 43% of companies and a moderate impact on 17% more. And with the majority of suppliers passing on increased cost, every company is feeling the squeeze. So what can a supply management organization do to improve the situation?

Use rigorous input price/cost forecasting processes
that integrate data from a large number of sources (public indices, private indices, third party market intelligence, etc.) and internal purchase price history. The processes should include years of historical data in the analysis and apply multiple forecasting models to arrive at most likely prices given current trends and models that traditionally work well under similar levels of price volatility.

Augment input cost forecasting with scenario-based business planning processes
that integrate input price/cost forecasts into a pro-forma profitability plan. The scenarios should consider the extreme cases where demand explodes or demand plummets so that the organization can also develop supply risk management contingency plans and estimate their associated costs so that the overall price/cost models are reasonable and capable of being rapidly adjusted if needed.

Employ advanced demand forecasting models
that create good demand forecast ranges to lock down supplier capacity and pricing. Given that one in four companies experiences significant price volatility by having to pull against limited supply, the last thing a supply management wants to do is have to spot buy in a tight market.

Centers of Excellence that use deep predictive analytics
to not only identify input costs that are likely to increase significantly or undergo increased volatility, but to develop detailed should cost models to support negotiations against undue supplier increases, to reduce supply needs of cost-inflated items by changing specifications or identifying alternate materials, and to identify non-price items that can be traded to off-set price increases (such as better payment terms, new business, or supply management support from your supply management organization). Analytics is a key technology for cost reduction and avoidance across the board.

Clear direction and strategy
for hedging and decision making. This needs to start with a cross-functional consensus on what the business objectives are. Is it to “beat the market”, even if it comes at the cost of establishing complex hedging processes? Is it to “smooth” supplier pricing? Or is it to “smooth” margins by the simultaneous optimization of sell-sie and buy-side commercial strategies. Supply Management and Finance must be aligned.

What Impact Will a 9% Drop in Profits Have On Your Organization?

Unless your Supply Management organization takes it to the next level, your company is facing a 9% drop in corporate profits this year due to rising prices and other inflationary pressure according to a recent Hackett Group study. For a typical Global 1000 company with 27.8 billion in revenue, Hackett’s study estimated that commodity and offshore labor inflation will drive a 150 million per year hit to the bottom line. Ouch!

Why? While most companies are now able to effectively anticipate commodity price increases, more than 60% of companies surveyed by Hackett in the recent study have not been successful at mitigating these cost increases. The reality is that few executives have experienced significant inflation, which is now at levels not seen in 30 years (when inflation rates hovered around 13% back in 1981).

And while inflation may not yet be at 13%, it is bad. Not only do respondents to the Hackett study expect the rate of inflation for commodities overall to rise by more than 30%, to 6.3% a year, but commodity price volatility has increased nearly 60% since before the recession. Making matters worse, at the same time, due to the talent crunch, the rate for internal labor is expected to more than triple from 0.7% to 2.2% and the rate of inflation for external labor is expected to more than double from 1.2% to 3%.

The problem, as identified by the Hackett study, is that most companies tend to take a fragmented, siloed approach to anticipating and mitigating costs. And while more advanced companies will forecast prices and do some basic hedging by adjusting contract length, purchase volumes, or inventory levels, few take the cross-functional approach required to combat the mitigation. The majority of companies do not do the analysis required to understand the impact of commodity cost increases on profitability, do not use specialized analytics to anticipate future commodity costs, and do not provide clear direction and policy for making hedging decisions. A future post will explore in greater detail some of the options presented in Hackett’s study on “Taming the Inflation Dragon” and why your organization must adopt more advanced

Is Your Supply Management Organization About to Move to Asia?

As per this recent article over on the McKinsey Quarterly on “Translating Innovation into US Growth: An Advanced-Industries Perspective”, the US is posed for a future in which the elements of economic leadership are moving abroad. The US might still be the global leader in R&D spending overall, but in order to maintain its competitive edge, it has to be able to devise innovations the world wants and needs and translate those into economic leadership.

Economic leadership requires more than a capital market system that encourages (and rewards) risk taking and entrepreneurship, more than simply attracting top students and teachers globally, and more than bulk spending. As per the article, it also requires cutting-edge technology, demand, talent, and entrepreneurial spirit. And, right now, the US is falling behind on each of these.

Cutting-Edge Technology
In leading industrial technologies — such as advanced batteries, high-speed rail, hybrid automobiles, solar modules, offshore wind turbines, and machine tools — the United States finds itself competing against, or even catching up, with foreign companies and engineers. Furthermore, as the article notes, the US is now relying on Japan, Russian, and Western Europe to launch its satellites — an industry it used to pretty much own globally. If the US can’t even compete in green energy, it’s in for trouble.

Demand
More than 50% of the global middle class now lives outside North America and the demand for many next-generation products is now coming from Asia, Latin Ameria, and the Middle East. These customers are creating new markets and dictating preferences. US products for the US market are no longer profitable on their own in many industries.

Talent
Scientific and engineering talent is now building up outside the US while one-third of US manufacturing companies are suffering from skills shortages. Cutting edge research is moving to India and China as well as accelerating in Japan and Germany.

Entrepreneurial Spirit
Once a mainstay of the private sector, risk aversion to new vetures is increasing across the board in the US. At the same time, the “new” India is becoming much more entrepreneurial and risk taking. It’s not a good combination.

Then, when you also consider:

Cost
Many emerging countries have labour and overall operating costs that are still only a third of labour and operational costs in North America or Europe.

Success
A number of global multinationals, including IBM, have proved that you can move global Financial, Services, and Supply Management organizations to China and India and still be a world-class organization.

it becomes impossible not to ask if your supply management organization is about to move to Asia.

Should You Manufacture That Product?

A recent article over on Industry Week that asked you to “show me the money” laid out six money questions that the author believes should be asked and answered before a manufacturing decision is made because a product that can’t be manufactured affordably shouldn’t be manufactured at all. As a supply chain professional, it’s your job to ask, and answer, these questions even if product development doesn’t, and even if the product can’t be cut, your job to figure out if it’s cheaper to build in house or outsource.

So, what are the key questions that should be answered?

  • How much will the total project cost?
  • How many products will be sold in a year? and
  • How many years will it take to get your investment back if you manufacture in house?

If the ROI will take years because an investment in new technology is needed, then, even if outsourcing adds cost, it might be the right idea.

For more insights, including the questions to asks (and calculations to do) if you’re trying to decide whether or not to manufacture a product in the first place, see the article.

Procurement Is Worth IT

So listen to the CPO Agenda when it says that Procurement Professionals should get bonuses, even though it might make this recommendation for the wrong reasons.

If Sales gets bonuses for making a sale, which brings the organization X cents to the bottom line for every dollar sold, then Procurement, which brings the organization 5X to 20X cents to the bottom line for every X dollars saved should definitely be in line for a bonus.

Plus, as the CPO Agenda suggests, if fixed costs are still a problem from a (short-sighted) organizational viewpoint, performance-based bonuses should be much less of a problem, especially if they are based on cost avoidance or savings, as a CFO can’t argue with numbers that improve the bottom-line 10X as much as the same numbers from Sales improve the bottom line.

Plus, if you want to retain talent, this is the best way to do it. Just like a hedge fund manager jumps to the investment house that will give him the biggest reward, your stars are going to jump to the organizations which give them the biggest rewards. And as much as you’d like to think that work-life balance, empowerment, and sustainability are important to your team, in general, nothing compares to a bigger paycheck which gives your star the ability to control their own work-life balance, a feeling of empowerment, and the ability to financially support their own sustainability goals.

So give your stars performance-based bonuses. They’re worth it.